The Good, The Bad and the Ugly

THE STOCK MARKET IS GETTING FRUSTRATING enough for investors caught in its trap to chew off their own legs just to get away.

Last week, we had bad news on the economic front and the market rallied. Then, we had good news on the earnings front and the market sold off.

War drums in Iraq, oil markets in crisis thanks to Venezuela, a nuclear threat in Asia thanks to North Korea -- you name it, and we can find reasons to worry. Then you look at the other side of the coin and see such things as a sharp rally in the copper market -- you know, the one some people say should have a Ph.D. in economics because of its strong direct ties to economic activity. No wonder investors are having trouble deciding what to do!

OK, so the market is being pulled in many directions. Well, when in doubt, go defensive -- and certainly the recent recovery in some health care, tobacco and food stocks has vindicated that approach. Gold stocks should also be a safe haven in uncertain times, and they sure did have a nice rally.

But then they stalled, even as the price of gold itself continued to move higher. What's up with that? If ever there were a time for gold stocks to rally, it is now, with impending war, a weak dollar, terrorism and other things to make investors nervous.

Now, if we look at crude oil we have not one but two reasons to be bullish. Not only are there potential supply issues in the Middle East because of an imminent conflict, but there are also supply issues thanks to Venezuela (see Weekday Trader, "Venezuela Crisis May Fuel Oil Firestorm," December 10, 2002).

Oil stocks should be moving higher, but one look at the American Stock Exchange's Oil and Gas index shows something completely different (see Chart 1). The only thing that can make oil stocks go down when their asset prices go up is lack of demand for their products. In other words, this says the opposite about the economy than copper does.

Chart 1

So, what are the major indexes doing during all of this? The Standard & Poor's 500 is stuck in a trading range after failing to break out last November (see Chart 2). Pundits were calling for a major rally because of the apparent double bottom, or "W" pattern, formed by the July and October lows, but they never got the actual breakout signal from the market. That prices are lingering fairly close to resistance is a positive sign, but rather than pointing to a rally, it merely points to the lack of a collapse. In other words, a trading range.

Chart 2

One look at a long-term chart shows that the S&P is still running in place as it awaits a major showdown with its bear market trendline some time in February (see chart 3). At its current rate of descent, the trendline will meet the S&P's resistance zone (centered roughly on 960) in just a couple of weeks. Until then, buying support and selling resistance in the trading range seems to be the only way to go -- if you are a professional trader. The rest of us will have to wait for the stock market messiah to appear.

Chart 3

That may take a while. A quick look at sentiment, as measured by the Chicago Board Options Exchange volatility indexes (VIX and VXN), suggests that conditions now are closer to those seen at market tops than at market bottoms.

While the so-called "fear index" based on the S&P 100 options market has seen a rise this month, it remains quite low. When it gets to an extreme low, the contrarian signal kicks in and the market usually turns down. It may not be at an extreme now, but it is clearly not at a level where major rallies begin. The Nasdaq 100 options market is even more worrisome (see Chart 4).

Chart 4

While technology stocks were taking it on the chin last week, the VXN declined, and it is still at levels low enough to at least worry the bulls a little. Traders seem a little too hopeful and when that happens, bad things can happen.

We have argued in this column that the bear market may actually be over, and that still seems to be the case. But it is critical to differentiate the end of a bear market from the start of a bull market. We can see big cyclical swings, and new lows, for quite some time before conditions finally become ripe for a true bull market to emerge.

Are investors anticipating the recovery in the market? Well, if they are, then conditions are not yet ripe. Bull markets start when nobody cares anymore.

Michael Kahn writes the daily "Quick Takes Pro" technical newsletter (http://www.midnighttrader.com). He is the author of two books on technical analysis, most recently Technical Analysis: Plain and Simple, and was Chief Technical Analyst for BridgeNews. He also is Director of Marketing for the Market Technicians Association (www.mta.org).

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